What does disruption mean for investing?

Can a disciplined investment process deal with rapid change? Rigorous analysis of historic numbers seems at odds with disruption and a radically different future. Economic revolution seems to question the very concept of consistent growth. The process of investing may now need to adapt to involve informed guesswork on innovation and adoption of technology. Investors who are most comfortable with numbers face a psychological challenge. Is prediction fact-free?

Certainly, company lifespans are getting shorter. Although we all want to be long term investors, companies may not outlive the average pension plan. Of 81 companies that joined the Fortune 500 between 1955 and 1960, just 7 are left today. Disruption has not only hit industrials and media, but is now accelerating in retail, consumer services and finance. The impact on retailers is being felt in most western nations and has moved from hitting city centres to affect the shopping centres and malls that were once seen as the future. The challenge is not just delivery technology, but an evolving change in consumer tastes that favours services over goods.

Technology is the best performing sector this year in the US, and joint top with financial services in Europe. This is despite technology’s high rating, suggesting that investors now place greater value on future earnings and growth prospects. Some of these are enabling or B2B businesses that may not be dependent on the outlook for a single customer sector. For example, the technology underlying self-driving vehicles may have wider applicability and greater value than car manufacturers themselves. And, a number of young disruptive companies are coming to the stockmarket, often with innovative business models, radically different from the incumbents they are attacking. Active investors may be able to move faster than passive funds to bring these IPOs into portfolios with a meaningful weighting.

Investors may need to incorporate some emerging businesses into their portfolios, ideally trying to capture these at an earlier stage. They also need to understand what are likely to be successful strategies, based on proven disruptive approaches. Some of this will be out of investors’ comfort zone. Factors in success may include managers and directors with experience of experiment and failure. But at least that failure should be in the rear view mirror, in contrast with traditional businesses where the real problems have yet to come.

Winning disruptors may also share common ground in how they operate; focusing on customer experience, delivery, brand value and scalability. Surprisingly, not all are digital or online models – London-listed Fevertree Drinks, for example, has rapidly built scale and competitive advantage simply selling mixers on a capital-lite model. Despite a £2bn capitalisation, like ASOS, it remains on the London Alternative Investment Market, AIM. Investors waiting for a full listing or capital-raise from these types of businesses may need to be very patient.

Investors also need to think harder about incumbent businesses that may be seeing new entrants steadily poach their customers. Initially the disruption may still be under the radar, and the headwinds faced by established groups might not be clearly understood. Some of the attrition in market share could be lost amidst macro and seasonal noise – dismissed as weather, temporary margin pressure or just a soft quarter. Sectors under attack may reclaim some value via consolidation, yet without providing a long term fix. Investors are only likely to win in this scenario if they correctly pick the last man standing in a sector, or find a business which manages an orderly run-down and exit to deliver a cash return. Worse case is when challenged businesses desperately acquire or market to recover lost business – HMV showed what can happen.

Investors can use traditional DCF approaches if they can estimate eventual market share, margins and the investment required. But the picture might be cloudy and a spread of investments may be wiser. Incorporating new sources of information could help to understand trends, and diverse teams may bring more flexible thinking. Investors also need to consider whether they can tolerate shares without dividends, or whether pay-outs from some older businesses might actually be at risk.

The upheaval in business methods and technology has much further to run. Disruption needs to be considered in asset allocation and company analysis.

Disclosure: The opinions expressed in this article are my own, and may not represent the views of any firm or entity with which I am affiliated. The information presented in this article has been obtained from sources believed to be reliable; however, I make no representation as to their accuracy or completeness and accept no liability for loss arising from the use of the material. Articles and information do not represent investment advice.

Client funds hold positions in Fevertree Drinks

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